An attempt to explain in ordinary language the bizzare bazaar that is our financial system.

Monday, March 1, 2010

Darn it, every time we order Chinese I get the same fortune "You will own more Dubai assets."

Generally if you are a blogger the prediction business is a bad business. This is because it is pretty easy to look up your old predictions and find out whether they worked out or not. In an earlier incarnation of this blog I recommended two trades. One was a sale of SPY strangles which manifestly did not work out. The other was trading a reverse collar on gold which has worked out quite well. In my last post I tried to predict the prices of all assets in dollar bloc countries based on an attempt to read the mind of the Chairman of the Federal Reserve. I know it’s a bad business but in this case I can’t resist.

So what have we found out about the Dubai World saga in recent days? Interestingly Arabtec and Aabar have extended the due diligence period. This is a little disturbing but more interestingly Arabtec, now that it is almost going to be owned by Abu Dhabi has stopped work on a Nakheel project because Nakheel has not been paying it. Do you think Arabtec would have stopped this work if Abu Dhabi were not involved? I think not. So what does it say about Abu Dhabi support for Dubai World if one of its own future contractors has stopped work on Nakheel for lack of payment? Nothing good.

There are also the recent reports out from Moodys and the IMF about the exposure of the Emirati banking system to Dubai World. It turns out that the exposures of ADCB and Emirates NBD to Dubai are quite substantial. Emirati banks are owed something on the order of $15 billion by Dubai World entities and billions more by other government related entities. The IMF suspects that massive amounts of capital will have to be raised by the Emirati banks in the event that there is a partial recovery to the creditors of Dubai World, especially if it is on the order of $0.60 on the dollar.

And what of that report that the $0.60 on the dollar figure was something contemplated by Dubai World? Dubai has denied that this offer was made but that is not inconsistent with the article which said the offer was under consideration not that it had been made. Also one has to remember the penalties in terms of access and other tragedies that might befall journalists that one would suffer for printing a wholly fictitious story in Dubai about Dubai. Personally I think there must be some truth in the report at least as an indication of the scale of losses the creditors of Dubai World are likely to suffer.

The creditors of Nakheel are likely to do far worse. We won’t have to wait too long to find out how much worse, Nakheel has requested details of its bondholders in case it has to offer a securities swap to them. Well, it will have to because it doesn’t look like it has the capacity to pay them and from the Arabtec work stoppage I think we might be able to infer something about the level of support that Nakheel can expect from Abu Dhabi.

I think the easiest way to try to estimate what is going to happen over the next few months is to try to put yourself in the position of the most powerful actor in the unfolding drama: Abu Dhabi. So it is probably clear to the powers that be in Abu Dhabi that Dubai World is largely insolvent. At the very least Nakheel and Limitless are almost certainly insolvent, and Istithmar probably has negligible positive equity if it were to be liquidated. So whether the value of the Free Zones and DPW is larger than the balance sheet hole in Nakheel (also doubtful) will determine whether there will be much left to pay the creditors of the parent company. It is also possible that Nakheel is seeking information about its bond holders to try to discover whether or not it is likely to be able to secure approval for a securities swap. If enough vulture funds have bought the Sukuk to block a restructuring and force a default in what I think is a vain hope that Abu Dhabi will rescue it again, then they won't even be able to effect the swap. I think it is increasingly likely that the restructuring, if it occurs, is likely to be highly coercive to the creditors and that an outright liquidation is growning more likely.

As far as the foreign creditors are concerned I’m pretty sure no one in the UAE will care very much. Dubai is going to be shut out of international capital markets for some time if only because it’s credibility has been obliterated. Abu Dhabi will still have access but not require it because of its capacity to fund itself. The trouble is that a coercive restructuring of Dubai World has a very good chance of touching off a banking crisis inside the UAE. This is because the balance sheets of ADCB and Emirates NBD will be severely damaged and they may be forced to raise capital. Let’s assume that happens. What will be the next move.

Well, I don’t think that ADCB will have difficulty raising capital or receiving support from the Central Bank given the influence of Abu Dhabi on that institution. What about Emirates NBD? Well, remember Emirates NBD is the largest bank in Dubai and was created in a forced merger between Emirates Bank and the National Bank of Dubai. I remember laughing as I read about it when it was announced because there were no merger terms announced at the time, it was just announced that they were merging. It was clear that Sheikh Mohammed had decided that Dubai needed a banking champion and to create the largest bank he could be compelled the merger between the two largest banks. The CEOs knowing they had to do what the Sheikh told them but not knowing how to go about it simply announced the merger but no terms.

Fast forward to today. The Dubai World crisis is presenting Abu Dhabi with yet another opportunity to strip Dubai of more assets. If you think about if the Sukuk holders force a default, the liquidation of Nakheel would be a bonanza for Abu Dhabi based investors. While any international investor can buy the bonds of Nakheel only GCC nationals can buy the real estate behind them. So in a liquidation sale cash rich GCC nationals (read Abu Dhabi nationals as opposed to Dubai nationals) will be able to scoop real estate from panicked Sukuk holders. I’ll bet you a dollar that when the Dubai World restructuring is announced ADCB and Emirates NBD will both be forced to raise capital. ADCB will receive a combination of aid from ADIA or Aabar and the Central Bank. Emirates NBD on the other hand will be forced to merge FDIC style with a stronger institution based in Abu Dhabi. First Arabtec, then Emirates NBD. Who knows what’s after that?